toolbox

pages

watchers

Expert tip #5: Click 'Help' in the menu to learn more about Wikidot syntax

Demand Planning

Activity based Costing: What is it and how does it work?
Activity based costing or ABC is defined as a method of allocating overhead costs to products and services which generally involves determining the actual cost of a particular activity in the production process. Moreover, ABC enhances the costing process in several ways. One is that it expands the cost pools that are beneficial to the assembly of overhead costs. Another is that it modifies the nature of indirect costs of products. In other words, it makes indirect costs into direct costs such as depreciation and power.

Process
In order to further understand what activity based costing is, the process of how it actually works must be thoroughly discussed. The process of how ABC works is best explained by these series of steps to be followed.
• Identify costs – the first step ABC method is to identify the required costs to be allocated.
• Load secondary cost pools – creating secondary cost pools is crucial in a company specifically to avoid direct costs.
• Load primary cost pools – primary cost pools are needed to be created in order to provide services that are more closely aligned.
• Activity drivers – use system specifically for the purposes of data collection in order to easily allocate the costs in secondary costs pools into primary pools and from primary cost pools to cost objects, thereafter.
• Allocate costs to pools – use the resulting cost allotment from the activity drivers to precisely allocate costs for primary and secondary cost pools.
• Costs to cost objects – From the cost pools, use again the activity drivers to precisely allocate costs to particular cost objects. In order to allocate the costs, one may use the equation where the total cost in each cost pool is divided by the total amount of activity used by the cost pool.
• Formulate reports – evaluate results obtained from the ABC system.
• Act on the reports – apply necessary changes to the production based on the results of the ABC system to attain maximum profit.

Other methods of allocation
Aside from ABC, lean accounting can also be used to provide thorough accounting and control systems without the hassles and costly methods from ABC method. However, lean accounting is more applicable in lean manufacturing where services are more focused on industries such as healthcare, construction, and financial services.